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Founded in 2004, China Digital TV (STV) is the leading provider of conditional access [CA] systems to China’s rapidly growing digital television market. As of March 31st, 2008, China Digital TV had installed CA systems at 170 digital television network operators in 27 of the 32 provinces, autonomous regions and centrally administered municipalities in the People’s Republic of China.

1. Business description

STV is the leading CA system provider in the PRC. As of Q1 2008, STV has a market share of 51.5%. Out of about 300 major TV network operators, STV has already been installed in 170 of them in 27 provinces.

2. How the business works

STV signs contract with TV network operators, installing the software of security, management, billing, etc. for them. Then a STB (set top box) producer cooperates with STV to produce compatible STBs for the subscriber, paying a service fee to STV. TV network operators also give subscribers a "smart card", which is used to limit access to TV content, billing, etc.

Instead of charging subscribers for both the smart card and STB, the TV network operators give the box to subscribers for free; they then increase the monthly fee from $1.5 to $3. A development bank gives the TV network operators low interest loans to upgrade to digital. STV gets paid when smart cards are sold. 90% of STV's revenue comes from the smart cards sold; the rest comes from the software and service fees.

3. The market

The market is very competitive. There were around 20 competitors just two years ago; now, only 7 remain in the market and STV has half of them. Local competitors are using pricing wars (half price) to compete with STV, but it doesn't seem very successful so far. With 51.5% market share and economic of scale, STV is still gaining market share and reducing the average cost of smart cards successfully.

Currently in China, digital TV has only a 7% penetration rate. Out of 374M TV households, only 27M subscribe to digital TV, so far. This number is expected to increase to 45.88M in 2010, half of which will be STV subscribers. The central government is pushing digital TV through regulations: by 2010, the government expects that all content will be digitalized in central counties, and in most western counties by 2015. All except 6 analog TV channels will switch off analog TV broadcasting. Also, the government encourages digitalization through tax policy. TV network operators get a 5% tax benefit.

TV network operators have a high incentive to use digital TV:

  1. No cash out of pocket, commercial banks will give them financing discount.
  2. All the cost will be covered and more profits will be coming from $1.5 to $3 increase.
  3. 5% of revenue tax benefits.
  4. In 2008, CCTV will give them all the digital content of the Olympic Games for free.

STV is uniquely positioned in this fastest growing market with 51.5% market share. In Q1 2008, STV signed 6 new contracts out of a total of 9 contracts signed. That reflects STV's competitive advantage in this market.

4. Management team

This is the best management team I have ever seen (so far) in China stocks. All executive team members graduated from TsingHua University (the premier engineering school in China); most of them speak fluent English. CFO Mason Xu holds an MBA degree from Harvard University. He speaks fluent American English just as well as his oral Chinese.

5.  Future potential

The company expects to ship 11M smart cards in 2008. At the current growth rate, the market will mature after 2010. STV has already begun investing in the future. The future lies in the value added service. As Mason has said, STV holds today's number one position in the market because STV invested in the CA TV market 6-7 years ago. Of course, the future is never predictable and the market is highly competitive. But with a management team that can think years ahead, including a strong research team and many TsingHua graduates, I expect STV to do reasonably well in the future.

6.  IPO

The company did an IPO in October 2007 at $16 per share. It was a hot stock then. The stock price went up to the $50s and has been coming down significantly since. I guess many speculators are pissed off today if they have not yet sold. But the company itself has actually been growing at rapid rate, quarter after quarter. After all, where do you buy a stock, which has > 50% market share, 80% gross margin, 60% operating margin and grows about 50% per year and is selling at P/E=10 if you exclude cash in hand?

7. Valuation

  • Market price: $12.14
  • Shares Outstanding: 61M
  • FEPS: $0.8
  • Cash: $4 per share
  • P/E: 15
  • Annual Growth Rate: about 50%
  • Op Profit Margin: 55-60%
  • 2008 guidance: revenue 79M-84M, net income $48M.

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Disclosure: none

Source: The Case for China Digital TV